OECD economic surveys china

Assessment and recommendationsChina has weathered the global crisis remarkably well and its importance in the world economy is set to grow further Since the OECD’s first Economic Surve

OECD Economic Surveys C

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Volume 2010/6

February 2010

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non-member Countries: Most recent editions

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OECD Economic Surveys

CHIna

SPECIaL FEaTURES: MOnETaRy anD FInanCIaL POLICy, PRODUCT MaRkET

REgULaTIOn, InEqUaLITIES anD SOCIaL POLICIES

ISSn 0376-6438

2010 SUbSCRIPTIOn

(18 ISSUES)

OECD Economic Surveys:

China 2010

AND DEVELOPMENT

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Table of contents

Executive summary 10

Assessment and recommendations 11

Chapter 1 Achievements, prospects and further challenges 19

Keeping up robust growth 20

Weathering the global crisis 30

The social policy challenge 40

Notes 44

Bibliography 45

Chapter 2 Further monetary policy framework reform 47

Monetary policy has come a long way 48

The modus operandi of the PBoC 49

The influence of the PBoC on the interbank market 50

How responsive is bank lending to money-market conditions? 53

The way forward for interest rate reform 54

How sensitive is the real economy to interest rate changes? 56

Do changes in aggregate demand influence inflation in China? 59

China’s exchange rate regime 60

The benefits of moving towards a flexible inflation target 65

Notes 66

Bibliography 68

Chapter 3 Progress on financial reforms: an update 71

Financial reforms have accelerated and broadened since 2005 72

Banking reforms are coming to fruition 72

Capital market development is accelerating on a firmer foundation 81

Greater priority is being given to improving credit access for underserved segments 89

The financial system is gradually opening up internationally 93

Conclusions and recommendations 97

Notes 98

Bibliography 99

Chapter 4 Product market regulation and competition 101

Product market regulation has been transformed but could be improved further 102

The OECD’s PMR indicators 103

Product market regulation is still restrictive in China 104

But competition is increasingly robust in most markets 105

SOE governance has been comprehensively reformed 109

SOE performance has improved but still lags the private sector 110

Detailed PMR indicator results and policy recommendations 113

Notes 126

Bibliography 127

Chapter 5 A pause in the growth of inequality? 129

Regional development policies 131

Policies in favour of rural areas 134

Government policies to reduce household income inequality 135

Measuring household inequality 137

Measuring spatial inequality 141

Conclusions 147

Notes 149

Bibliography 149

Chapter 6 A labour market in transition 153

Labour market developments: job creation, migration and persistent segmentation 154

New labour laws 169

Conclusions and recommendations 176

Bibliography 178

Chapter 7 Providing greater old-age security 181

The demographic and social context 182

The rural old-age support system 188

The urban old-age support system 194

Overall conclusion: further reform directions 204

Notes 204

Bibliography 205

Chapter 8 Improving the health care system 209

Health performance 210

The health system 215

Financing of health care 220

Government initiatives 222

Assessment and conclusions 227

Notes 230

Bibliography 230

Boxes 1.1 Second Economic Census: China’s economic size revised up 20

1.2 Improving energy efficiency and reducing pollution 22

1.3 Enhancing innovation capacity 25

1.4 How dependent on exports is China? 32

3.1 China’s rules for calculation of capital adequacy and loan classification 73

3.2 Designing efficient deposit insurance schemes 79

3.3 Reform of the non-traded shares 82

3.4 China’s informal financial facilities 90

3.6 Sketch of China’s capital control regime 94

5.1 Estimating continuous income distributions for China 138

5.2 Inequality indices 140

5.3 Inequalities in Guangdong province 143

6.1 Measuring unemployment 155

6.2 Measuring employment 156

6.3 The hukou system 164

6.4 Income tax and social insurance contributions 175

7.1 Property rights in rural areas 189

8.1 The smoking epidemic 213

Tables 1.1 Level and improvement of living standards 21

1.2 Factors contributing to output growth: 1988-2008 25

1.3 R&D Intensity of Chinese companies by level of technology 26

1.4 Macroeconomic developments and prospects 30

1.5 Saving, investment and the current account balance 31

1.6 Sectoral saving balances in China and the OECD area 31

1.7 Spending plans and tax cuts announced between October 2008 and April 2009 33

1.8 General government appropriation account 35

1.9 Household appropriation account 38

2.1 PBoC targets and outcomes 49

3.1 Non-performing loans of commercial banks 73

3.2 Progress in meeting minimum capital adequacy 74

3.3 Pre-tax profits of commercial banks 75

3.4 Deposit insurance in selected countries: main features 80

3.5 Stock market profile 83

3.6 Outstanding bonds by type 84

4.1 Market concentration in the industrial sector 105

4.2 Industry concentration and state ownership in the industrial sector 108

4.3 Various estimates of TFP growth over the reform period 108

4.4 Comparison of SOEs and private firms in industry 110

4.5 State control in China, international comparison 113

4.6 Policy goals on state ownership across sectors 114

4.7 Industries with the highest degree of state ownership 114

4.8 Barriers to entrepreneurship in China, international comparison 119

4.9 Barriers to international trade and investment, international comparison 123

4.10 Tariff rates and their dispersion in China and selected countries 125

5.1 Aspects of the minimum living allowance system 136

5.2 Extent of poverty reduction through the minimum living allowance programme 137

5.3 Average earnings across Guangdong prefectures 144

5.4 Urban-rural income differences by income source 146

6.1 Employment and unemployment 155

6.2 Estimates of urban employment by sector 156

6.3 Rural employment 158

6.4 Origin and destination of unofficial migrants: population and employment 165

6.5 Sector and occupational status of urban workers 166

6.6 Employment status and earnings of urban workers 167

6.7 Employees without contracts by type of enterprise 170

6.8 Coverage of minimum wage rate in five major cities 174

7.1 Projections of elderly population and dependency ratios 184

7.2 Labour force participation rates by age 186

7.3 Odds ratios for feeling rich or poor in 2005 188

7.4 A comparison of rural social pensions across emerging countries 193

7.5 Economic structures when rural social insurance was introduced 193

7.6 Income and assets of Social Security funds 198

7.7 Social coverage for migrant workers 199

7.8 Replacement rate under various assumptions 201

8.1 Staff size and education level of community health centres and stations 216

8.2 Number of doctors by level of training 217

8.3 Training required to become a doctor 218

8.4 Reimbursement rules and benefits in different rural medical insurance systems 224

8.5 The new urban health insurance system: coverage by city 226

Figures 1.1 CO2 emissions and energy intensity 22

1.2 Shares in world manufacturing output 24

1.3 Physical assets and employment in industry by ownership 27

1.4 Impact of changing sectoral employment shares on productivity growth 29

1.5 Level of education by year of entry to primary school 30

1.6 Evolution of exports and imports during the downturn 32

1.7 Government spending and deficit on a budgetary basis 36

1.8 Quarterly outlay path for infrastructure spending 36

1.9 Financial assets and liabilities of the government 37

1.10 Proportion of urban households owning cars by income decile 39

2.1 Bond market issuance 50

2.2 Short-term money-market interest rates 52

2.3 Required and excess reserves 52

2.4 Commercial lending rates and the repo rate 53

2.5 Equity and debt to total liability ratios in listed Chinese firms 57

2.6 Impact of a one percentage point increase in real policy rates on investment 58

2.7 Changes in inflation and the output gap 59

2.8 Bilateral and effective exchange rates 61

2.9 The balance of payments and foreign exchange reserves 61

2.10 PBoC sterilisation and base money 62

2.11 Inflation and business cycle volatility across countries 64

3.1 Loan-loss provisions of major commercial banks 74

3.2 Consumer loans outstanding 77

3.3 Bank market shares 78

4.1 The structure of the PMR indicator system 103

4.2 The overall indicator of product market regulation (2008) 104

4.4 The relative size of the state-enterprise sector 106

4.5 Differences in total factor productivity by firm ownership 111

4.6 Distribution of rates of return on physical assets 112

4.7 Capital intensity and state ownership 115

4.8 SOE penetration and market concentration, 1998-2007 121

4.9 FDI inflows to China by sector 124

5.1 International comparison of inequality 130

5.2 Investment share in the West 131

5.3 GDP per capita across China’s main regions 133

5.4 Junior secondary school graduation rates by region 134

5.5 National household income distribution 138

5.6 National rural and urban Gini coefficients 139

5.7 National rural and urban Atkinson inequality indicator 140

5.8 Gini coefficients of different measures of inter-provincial inequality 141

5.9 Extent of inter-province migrant flows by province 142

5.10 Sources of the rural-urban income differential 146

5.11 Inequality of health outcomes 148

6.1 Distribution of the population between work, studies and unemployment 159

6.2 Urban employment 159

6.3 Composition of non-agricultural employment 160

6.4 Absolute growth in employment by region 161

6.5 Growth of average earnings by region 162

6.6 Sources of growth of the urban population 168

6.7 Strictness of employment protection laws 171

6.8 Minimum wages in cities relative to local average wages 174

6.9 The estimated tax wedge in 2007 176

7.1 Sources of income for the elderly by age 185

7.2 Relative poverty amongst the elderly 187

7.3 Coverage of the pension system in towns and cities 198

7.4 Simulation of pension deficits under different assumptions 202

7.5 Pension replacement rates in the government and enterprise sector 203

8.1 Cases of infectious diseases 211

8.2 Years of life lost due to non-communicable diseases 211

8.3 Expected healthy years of life at birth 212

8.4 Cigarette consumption per capita and affordability 213

8.5 Provision of care by level of institution 216

8.6 Health care spending by consumers relative to total health care and total consumer spending 220

8.7 Health care insurance: the extent of coverage 222

the main author under the supervision of Vincent Koen The other contributors were Paul Conway, Sam Hill, Yu-Wei Hu, Charles Pigott and Anders Reutersward Consultancy support was provided by Yufei Pu Analysis of Chinese microeconomic data was undertaken by Ping He and Jianxun Yu of the Chinese National Bureau of Statistics Technical assistance was provided by Thomas Chalaux, and secretarial assistance by Nadine Dufour and Lillie Kee.

The Survey was discussed at a special seminar of the Economic and Development Review Committee on 16 November 2009, with participation of representatives of the Chinese government.

The Survey is published on the responsibility of the Secretary-General of the OECD.

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FOREIGN TRADE

Main exports (per cent of total exports of goods):

Main imports (per cent of total imports of goods):

Executive summary

Since the OECD’s first Economic Survey of China in 2005, China has continued to expand rapidly.

The economy is also weathering the global crisis remarkably well, not least thanks to prompt and

vigorous macroeconomic policy action Economic expansion is projected to continue over the medium run,

and China’s share in the world economy is set to grow further Despite the recent decline in the current

account surplus, some imbalances remain, notably an overly high national saving rate, but ongoing

reforms can be expected to help alleviate them over time Structural reform has continued on a broad front

in recent years, with an increasing focus on the need for social cohesion Even so, efforts are under way or

still needed in a number of areas to sustain improvements in living standards over the longer run.

Further upgrading the monetary policy framework China’s monetary policy framework

has gradually become more market-based, with money growth as the main intermediate target Going

forward, it will need to place less emphasis on quantity-based liquidity controls and more on interest

rate changes Allowing greater exchange rate flexibility and putting more weight on an inflation

objective would offer greater scope to tailor monetary policy to domestic macroeconomic conditions.

Continuing financial market opening Chinese financial institutions are now generally

stronger and better regulated than a few years ago and the financial system is gradually opening up.

However, further reforms are in order, including raising the ceilings on foreign investment in this

sector, expanding the corporate bond market, creating a formal deposit insurance system for

commercial banks and strengthening supervisory capacity Moreover, continued vigilance is called

for to avoid a build-up of loans that may underperform.

Lowering product market barriers Competition is now robust in many sectors but product

market barriers remain high overall, which may hold back growth over the longer run Competition

and productivity gains can be boosted by loosening the traditional ties between state-owned

enterprises and central authorities, reducing administrative burdens, allowing greater private sector

involvement in network sectors and lowering barriers to foreign direct investment in services.

Unifying social safety nets Ambitious reforms have been launched in the social sphere in

recent years and tangible progress has already been achieved, in particular with respect to education

and to the coverage of the social safety net, albeit with the exception of unofficial migrants Further

progress will require overcoming the enduring fragmentation of the welfare assistance, pension and

health systems, accompanied by greater fiscal solidarity across the country.

Facilitating labour mobility The labour market is resilient but segmented The registration

system and the attendant restrictions on migrants’ access to social services impede labour mobility

and ought to be gradually relaxed.

Consolidating pension regimes Providing sufficient replacement rates to pensioners will

require shifting more of the cost of pensions, notably those in the rural areas, to the central

government and raising retirement ages.

Pushing ahead with health care reform Progressing towards universal, safe, affordable

and effective basic health care will require that primary care play a greater role, hospitals be

managed more efficiently, changes in some relative prices, better trained staff and ultimately

Assessment and recommendations

China has weathered the global crisis remarkably

well and its importance in the world economy is

set to grow further

Since the OECD’s first Economic Survey of China in 2005, China’s economy has continued to

expand rapidly, driven to a large extent by the development of the private sector Exports

were hit hard by the global crisis and activity slowed down sharply over the course of 2008

However, prompt and vigorous policy actions, as well as swift adjustment in the labour

market, helped growth pick up by the second quarter of 2009, putting China in the lead of

the global recovery Going forward, China’s importance in the world economy is set to

increase further, as are living standards within the country In fact, China already has the

world’s second-largest economy in purchasing power parity terms, and is expected to

shortly achieve the same rank at market exchange rates It already has the world’s

second-largest manufacturing sector and is the world’s second-largest exporter of goods Growth will likely

continue to be driven largely by investment and a trend shift out of low-productivity

agriculture, as the urbanisation rate, which is approaching 50%, continues to rise While

the size of the labour force is not projected to increase much, education levels have soared

since the early 1980s, which will support future productivity growth

Macroeconomic policy has helped limit the extent

of the slowdown

In the face of the dramatic slump in exports in late 2008, both monetary and fiscal policy

levers were used in China, even more forcefully than in many OECD countries On the

monetary side, policy interest rates were cut in steps, as were required reserve ratios

Meanwhile, the gradual appreciation of the renminbi vis-à-vis the dollar in motion since

mid-2005 was put on hold, making for a sizeable effective exchange rate depreciation

Furthermore, a number of restraints on lending, put in place when the economy was

overheating, were relaxed On the fiscal side, low public debt and a high budget surplus

facilitated the introduction of a massive stimulus package Precisely quantifying the total

additional fiscal impulse is difficult as some outlays and tax reductions were already

programmed, but its scale clearly dwarfed fiscal responses in many OECD countries, both

in absolute and relative terms A major portion of the stimulus is in the form of extra

outlays on transport, energy and other network infrastructure, where needs remain

conspicuous Some new spending is also directed at social programmes, notably in health

care, and, to some extent, at environmental protection, areas that are key to ensure

sustainable growth The central government is slated to fund only part of the stimulus

measures, with local governments, banks and state-owned enterprises financing the rest.

Against this backdrop, credit soared during the first half of 2009 An important concern is

that the resources thus invested generate sufficient returns down the road

Imbalances remain but are being addressed

Saving and investment have long been very high in China In recent years, both household

and government net saving have increased further, leading to a widening current account

surplus, which reached double digits as a share of GDP in 2007 During the global

slowdown, imports held up better than exports, not least thanks to the injection of

macroeconomic stimulus As a result, the current account surplus is projected to shrink to

around 5½ of GDP by 2010 and economic growth is set to rebound back to double digits At

the same time, government saving is projected to fall, which is a welcome change In fact,

in recent years, the scale of general government budget surpluses has not been fully

appreciated by most observers, not least because the social security system is not

integrated into the national budget More generally, the quality and relevance of public

finance data would be improved by publishing aggregate financial data for all urban

development infrastructure companies and by greater transparency in the use of funds

from land use-right sales (which amounted to over 5% of GDP in 2007) Households’ saving

might also ease back gradually as the coverage and replacement rates of the broadly

defined social safety net increase and weaken the precautionary motive The deepening of

household credit markets and population ageing might possibly work in the same

direction Other imbalances and tensions remain, such as the continued existence of

inefficient capacity in some sectors of heavy industry, and severe environmental strains

On both scores, the government has recently made policy announcements, in particular

regarding its intention to encourage more efficient energy use Moving closer to

market-based pricing could help create the right incentives in this area

Higher levels of social spending need to be

sustained

Looking ahead at the exit from the ongoing fiscal stimulus programmes, it will be

important not revert to budget surpluses China had an enviably strong fiscal position on

the eve of the global economic crisis, and this will still be the case by 2010-11, even with

higher levels of public spending To support the social reforms launched or needed in areas

such as education, welfare assistance, pensions and health, the composition of

government outlays will need to continue to shift towards greater investment in human

capital and social transfers, with more redistribution across the country Greater public

spending on education in particular can help both to boost productivity and to reduce

inequality

Further modernisation of the monetary policy

framework is warranted

China’s monetary policy framework has gradually moved away from a planned

administrative system to a more market-based regime, with money growth as the main

making them more responsive to market signals, and the tools of monetary policy have

been modernised The central bank now has considerable control over short-term interest

rates in the interbank market and more influence over longer-term rates through the term

structure Going forward, the central bank’s operational framework needs to place less

emphasis on quantity-based liquidity controls and more on interest rate changes Its

benchmark commercial bank lending and deposit rates are losing relevance in the conduct

of monetary policy and ought to be progressively phased out The banking sector has also

undergone significant reform and the economy has become far more responsive to

market-based policy measures: investment at the firm level is more sensitive to interest

rate movements and changes in aggregate demand pressures exert a stronger influence on

inflation Hence, the transmission mechanism has become more effective in China and

monetary policy can play a greater role in fostering stability However, the current

exchange rate regime limits the effectiveness of this channel by preventing the value of the

currency from adjusting to offset macro shocks Allowing greater exchange rate flexibility

and putting more weight on an inflation objective – while keeping a vigilant eye on asset

prices – would offer the central bank more scope to tailor monetary policy to domestic

macroeconomic conditions and reduce the costs and risks of sterilising foreign reserve

inflows Besides, real exchange rate appreciation is to be expected in any event over the

medium run in an economy that is catching up rapidly

Banking and financial market reforms need to

continue

Considerable headway has been made in implementing key financial reforms, including

those reviewed in the previous Economic Survey This has been facilitated by the vigorous

economic expansion and, together with a limited exposure to toxic overseas assets, has

enabled Chinese banks to weather the global slowdown well so far The recent surge in

lending, however, carries the risk of imprudent borrowing by local authority infrastructure

companies and of a resurgence in non-performing loans Financial institutions have

broadened the scope of their activities, housing and consumer credit have expanded

rapidly and new financial instruments and facilities have been introduced The corporate

governance structures and risk management systems of the commercial banks have

improved Restrictions on the trading on the exchanges of state-owned and legal-person

shares have been eased and securities market institutions have been modernised In

conjunction with banks’ new ability to lend for mergers and acquisitions, this could create

a market for corporate control As yet though, there have been few examples of newly

tradable shares actually being traded Efforts have also been made to improve credit access

for underserved segments, notably small and medium-sized enterprises and rural China

Steps have been taken to relax controls on international capital flows, and Chinese

financial institutions are becoming a growing presence in OECD and other foreign

countries, although liberalisation has been slow and the foreign share of their assets

remains very small

Over the longer term, financial system development is likely to be conditioned by decisions

about broader economic reforms, for instance, with respect to pensions While State

ownership is likely to continue to prevail in the financial system for the foreseeable future,

the pace at which such arrangements should evolve as the private sector expands is a

major issue Raising the ceilings on foreign investment in banks and other financial

institutions would put pressure on these institutions to upgrade their governance,

management and technical capabilities, and would facilitate their international expansion

It would also help in light of the general need, in the wake of the global financial crisis, to

bolster bank capital and improve risk management Although the bond market has

expanded, corporate bond issuance remains relatively small Establishing a formal deposit

insurance system would help equalise competitive opportunities between larger and

smaller commercial banks Strengthening the Banking Regulatory Commission’s capacity

to conduct regular on-site examinations of more commercial banks would help accelerate

the implementation of banking reforms

Product market competition has intensified but

further regulatory reform is called for

Over three decades of liberalisation, including accession to the World Trade Organisation

in 2001, China’s product markets have become increasingly competitive and market forces

are now generally the main determinant of price formation and economic behaviour A

competition policy framework has been established and regulation of firm entry and exit

has improved Administrative reforms have enhanced the capacity of the central

government to oversee a market economy and regulation has become less reliant on

microeconomic interventions and more focused on framework conditions, even though

industrial policy is being stepped up in the context of the global economic crisis, in the

form of ten sectoral plans Moreover, the first vintage of the OECD’s indicators of the extent

of government intervention in products markets in China indicate that government

intervention remains pervasive, both in absolute and relative terms, and is on a par with

that in Russia This may constrain growth more and more as the economy continues to

develop Loosening the traditional links between state-owned enterprises and the

government is an ongoing challenge and one that can be best achieved by further reducing

the size of the state sector, especially amongst the smaller public-sector companies

Reducing administrative burdens, making room for more private sector involvement in

network sectors and lowering barriers to foreign direct investment in services would also

spur competition and productivity growth going forward

Major social reforms have been undertaken but

safety nets remain overly fragmented

Ensuring a sufficient degree of social cohesion and stability throughout the country has

been and will remain one of the overarching and increasingly prominent objectives of

public policy in China This will improve efficiency and the prospects for robust economic

growth and, in any case, is a desirable outcome of rapid economic expansion Many

ambitious reforms have therefore been launched in the social sphere in recent years and

tangible progress has already been achieved In particular, the coverage of the social safety

net has broadened, although much less so for unofficial migrants, who probably represent

over 40% of total employment in urban areas However, decisive further progress will

require overcoming the enduring fragmentation of the labour market and of the education,

welfare, pension and health systems, which some of the recent reforms have actually

accentuated Major improvements are also needed in the administration of benefits,

The needed unification of social protection arrangements should transfer responsibilities

for health care and pensions from cities to provinces and then to the national level A

nationwide system should involve greater fiscal solidarity across the country, but not

uniform entitlements, which should depend on local conditions and/or personal histories

This would greatly facilitate labour mobility, both from rural areas to towns and from one

city to another Substantial further migration is needed to sustain growth and

urbanisation

Income inequality may no longer be on the rise

though geographical disparities remain acute

Partly as a result of the various social reforms launched over the past decade, there are

encouraging signs that the trend increase in nationwide income inequality may have

paused in recent years A set of new indicators suggests that it may even have receded

somewhat in some respects In particular, income disparities across provinces have tended

to decline slightly in recent years, partly as a result of migration, which boosts incomes in

the poorer areas via remittances and tends to raise the wages of the remaining workers

That said, geographical inequality remains very high by international standards, despite

the Western Development Plan, which aims to boost the development of the sparsely

populated and under-developed West One reason for its limited success in that regard is

that the bulk of the expenditure under this policy has long been focussed on large

capital-intensive projects designed to bring natural resources to the coastal areas More emphasis

needs to be placed on education, especially in senior secondary schools, which would

boost human capital and help reduce income differentials over time, and on the

development of private entrepreneurship

The labour market has been resilient over the past

two years

The labour market has proved to be remarkably resilient in the face of the economic

slowdown, notwithstanding the scale of layoffs a year ago and the attendant fears of mass

unemployment Employment contracted during a few months in late 2008 and early 2009,

but has since started to expand anew, albeit at a less buoyant pace The migrants who lost

their urban jobs in large numbers in late 2008 had almost all found new urban employment

by mid-2009, although not necessarily in the same workplace This turnaround, which is

far swifter than in many OECD countries, reflects the bounceback in activity as well as

wage moderation, in particular migrants’ readiness to accept sizeable wage cuts

New labour laws were introduced in 2008

A set of new labour laws was introduced in 2008, replacing legislation from 1995 that

needed to be adapted to current market realities The objective was to better protect

employees in a market that is now dominated by private-sector employers This has

involved more systematic use of labour contracts to ensure that all employers adhere to

basic employee rights such as being paid on time However, the government has

underlined that the law is not meant to create life-time employment The new law may

also increase firms’ costs insofar as it leads to greater compliance with minimum wage,

hours worked and social security legislation In principle, individual employees will find it

easier to have their rights recognised, even if enforcing any resulting judgement may be

difficult As in other areas, the extent to which the new legislation and implementing

regulations will be enforced is of key importance Currently, the power of labour inspectors

to penalise companies is very limited For the time being, de facto employment protection

remains far less than de jure, with still a preponderance of fixed-term contracts involving

few restrictions In implementing the new laws, it will be important to avoid making

open-ended contracts too rigid, which would only entrench labour market dualism

Labour market segmentation hinders labour

mobility and needs to be reduced

While the restrictions associated with the registration (hukou) system have been eased over

time, especially in the inland and western regions, they still segment the labour market,

impeding geographical mobility and splitting families In larger towns, migrants can now

register as temporary residents but without the same rights as permanent ones The

government emphasises that migrant children need to receive education in towns but, in

reality, a large share of migrants’ children are left behind with grandparents and

regulations still stipulate that university admission examinations be taken in the locality

of the student’s hukou, based on the local syllabus The local registration system needs to

be phased out to end not just the distinction between the rural and urban populations in

one locality, but also the distinctions between localities and provinces More pilot

programmes ought to be initiated in major Eastern cities easing local registration and

hence access to social benefits such as education, subsidised rental housing and local

medical insurance on the same basis as local residents Extra grants from central or

provincial governments may be needed to that effect Other concurrent policy changes

may also be called for In particular, realistic compensation needs to be paid to the owners

of land use-rights when the latter are purchased by the government

Pension reforms have addressed only part of the

challenges faced by an ageing population

China’s population is ageing fast, owing to low fertility rates and rising life expectancy

With ongoing migration of the younger cohorts to urban areas, the old-age dependency

ratio will rise even more in rural than in urban areas A patchwork of pension

arrangements exists across the country, with diverse and segmented systems in urban

areas, belated retirement and low replacement ratios in rural areas, and special rules

governing public sector pensions This raises issues of efficiency, in that labour mobility is

impeded, and fairness, to the extent that work experience in one sector is not recognised

for pension purposes once the individual moves to another Urban pensions underwent

parametric reform around the turn of the millennium and again in 2005 On both

occasions, benefits were reduced Moreover, some geographical pooling has also been

introduced Nonetheless, contribution rates are low in areas that have experienced rapid

population growth through migration but much higher in cities with a declining industrial

base or a high share of elderly Measures were also taken in 2005 to raise the coverage of the

self-employed and those with flexible forms of employment A new rural pension scheme

of the recent reforms have increased fragmentation, while others, notably those providing

for greater geographical pooling, have not been fully implemented Also, under current

rules, effective replacement rates are fairly low and projected to decline further, both for

rural and urban residents This may be difficult to sustain, as the elderly are increasingly

unlikely to live with their descendants Furthermore, as most of the ageing population is

likely to be concentrated in the countryside, much of the additional burden will be

shouldered by local governments, many of which in poorer areas have insufficient

resources

The various pension regimes need to be gradually

consolidated, and the average retirement age

needs to be increased

These challenges can be addressed by gradually consolidating the various regimes, shifting

more of the cost of rural pensions to the central government, pooling pension

contributions nationally and increasing retirement ages Even if different schemes for

different categories of workers (employees versus self-employed in particular) are to

persist, each should be unified geographically over time, first provincially and then

nationally In the process, the distinction between rural and urban residents ought to be

phased out, in line with the recommended ending of the local population registration

system Retirement ages are currently very low and to ensure long-run pension system

sustainability they should in due course be raised incrementally, at least in line with rising

life expectancy, as is the case in some OECD countries For the time being, pre-funding

future government pension liabilities is not necessary, as national saving is already very

high

Progress with health care has been genuine but

incomplete

In many respects, health outcomes in China have improved tremendously over past

decades, in no small part thanks to the near eradication of some traditional infectious

diseases Overall, health outcomes are not so different from those in lower-income OECD

countries such as Mexico and Turkey, despite lower incomes in China However, health

status varies widely across the country and in general death rates from chronic diseases

have been on the rise, not least owing to changes in life styles, including greater tobacco

consumption Improving health outcomes will require addressing a number of imbalances

and incentive problems plaguing the health care system, in a context of rapidly rising

demand for care Health care is overwhelmingly publicly provided and hospitals have been

absorbing a growing share of public funding, at the expense of primary care The number

of doctors has increased rapidly but their qualification levels are often modest and their

geographical distribution does not match local needs Hospital budgets and their doctors’

pay are partly based on the pharmaceuticals they prescribe and sell, the prices of which are

regulated and involve considerable cross-subsidisation Against this backdrop, household

out-of-pocket medical expenses have soared Many of these problems have long been

recognised and since 2003 the government has launched several reforms to address them,

notably the introduction of new urban and rural insurance schemes As a result, coverage

and use of medical facilities has increased considerably, except for migrants Even so, both

catastrophic and chronic illnesses continue to push people into poverty, especially in the

poorer regions Given that risk pooling at the national level remains limited, it is often

impossible to provide patients with the reimbursement rates they are legally entitled to

A set of ambitious health care reforms are being

rolled out but more may still be needed

A new set of reforms was announced in April 2009, aiming at universal, safe, affordable and

effective basic health care by 2020 They involve additional spending of CNY 850 billion

over 2009-11 (equivalent to 0.8% of GDP over that period) While sizeable, this represents

just a down-payment on the extra spending that will be needed in the health sector over

the longer haul These reforms include investment in medical infrastructure, generalising

insurance coverage, more focus on prevention, retraining less-qualified doctors, a new

essential drugs system and far-reaching reorganisation, including of hospital budgets It

will be important to ensure that primary care plays a greater role in health care delivery to

reduce the inappropriately high demands on hospitals for minor health problems It will

also be important that hospitals are managed more efficiently, with less hierarchical

structures, and that the link between pay and prescriptions is abolished Prices paid by the

insurance system also need to reflect actual costs Indeed, failing to address these

supply-side issues would reduce the effectiveness of increasing insurance coverage, as many

countries have found Progress will also require changes in relative prices, in the form of

more attractive wages for doctors, less distorted prices for pharmaceuticals and higher

taxes on and prices for tobacco Once near universal coverage is achieved, including of

migrants in their place of residence rather than their place of origin, the different

insurance systems should be merged and a greater portion of their funding should be

shouldered by the central government

Continued structural reforms will help boost

living standards and alleviate macroeconomic

imbalances

In sum, China has launched many reforms which are starting to bear fruit, by supporting

domestic demand in the face of the global slowdown, helping to reduce internal and

external macroeconomic imbalances and by restructuring China’s economy In many

countries, undertaking structural reforms involves painful trade-offs between short run

costs and longer-run benefits, not least because public finances do not allow such reforms

to be undertaken without offsetting restrictive fiscal measures In contrast, China is in the

fortunate position to have room for continued, ambitious social reforms whose financing

can help bring down an uncomfortably high national saving rate By stepping up social

expenditure even as public infrastructure investment reverts to more normal levels, China

will enjoy higher living standards and greater internal social cohesion, and contribute to a

more harmonious global economy

Chapter 1

Achievements, prospects and further challenges

China’s spectacular economic expansion has continued in recent years, making for

impressive improvements in living standards The slowdown associated with the

global financial and economic crisis was contained by massive fiscal and monetary

policy stimulus, which has boosted domestic demand While the current account

surplus is shrinking, some macroeconomic imbalances remain, in particular in the

form of a high national saving rate A key adjustment will be to durably lower

government saving Ongoing social reforms can be expected to help in this respect,

provided they are sufficiently funded by the central government Rapid further

urbanisation will require greater labour mobility This calls for gradually phasing

out the still rigid registration system and the attendant differences in social

entitlements, notably as regards education, welfare assistance, pensions and health

care More accessible and better public services will also strengthen social cohesion.

To sustain vigorous economic growth beyond the ongoing recovery, it will be

important to further liberalise product and financial markets.

Over the five years to 2008, the Chinese economy has grown at an unprecedented pace

of about 11% per annum on average, before the upward revision to GDP as a result of the

second Economic Census (Box 1.1) While the expansion lost momentum in the course

of 2008, China has weathered the global economic crisis remarkably well and is at the

forefront of the world economy’s recovery On the structural side, market mechanisms and

the private sector have continued to gain importance, as foreshadowed in the first OECD

Economic Survey of China (OECD, 2005) The current Survey documents the extent of the

progress achieved in recent years, including the impressive improvement in living

standards, and highlights a number of broad policy challenges now faced by China

This Chapter focuses on internal and external macroeconomic imbalances, and on

how macroeconomic policies have recently helped to ease them, cushioning the impact of

the global slowdown The issue of macroeconomic management is then dealt with in more

detail in Chapter 2, which discusses monetary policy and options for reform The Survey

then turns to financial and product markets, building on the analysis in the first Survey.

The structure and performance of these key markets has continued to evolve in a manner

that supports development in the broader economy but further reforms are needed

Hand-in-hand with the development of a more market-based economy, social policies

need to be strengthened The Survey therefore goes on to examine income inequality and

how it is influenced by regional and social policies This serves as the background for an

in-depth analysis of policies in three areas directly affecting well-being – labour markets,

income security in old age and health In each of these areas, a recurrent theme is the

urban/rural divide, and how it can be addressed

Keeping up robust growth

Living standards have improved rapidly

Living standards have been improving at a stunning pace in China The estimated

growth in total real household consumption has been amongst the most rapid in the world

at 9.6% per annum in the five years ending 2008, almost two percentage points faster than

Box 1.1 Second Economic Census: China’s economic size revised up

After this Economic Survey was finalised, the initial results of the second Economic

Census of the secondary and tertiary industries in China were published As a result of the

discovery of new enterprises and better measurement of the output of existing enterprises,

the level of nominal GDP in 2008 was raised by 4.4% Nearly 80% of the upward revision

came from the service sector of the economy While the 2008 growth rate of real GDP was

revised upwards to 9.6% from 9.0%, real and nominal GDP data for the period 2005 to 2007

were not presented in the initial data For this reason, the pre-Economic Census data for

GDP are used throughout this publication

that in advanced economies By 2008, measured in purchasing power terms, private

consumption per head was just one-tenth of the average level in the OECD area and

between one-fifth and one-quarter of those in low-income OECD countries such as Mexico

and Turkey

The gains in aggregate private consumption are reflected in increased ownership of

consumer durables (Table 1.1) In urban areas, Chinese households are now well equipped

with electrical appliances Nearly all urban homes have washing machines and at least one

air conditioning unit, colour TV and mobile phone, while ownership of microwave ovens

and computers has spread The size of an apartment in urban areas rose by nearly

one-third since the early 2000s to 65 square metres for the average family of three In urban

areas, car ownership is becoming prevalent amongst the highest income decile Indeed, the

average household income level of this group (measured at purchasing power parities) now

exceeds that of 30% of US households However, the size of this relatively affluent group is

small, with no more than 50 million household members

In rural areas, living standards are much lower Household incomes are only 60% of

those in urban areas, allowing for differences in price levels Moreover, average household

size is greater in rural areas, implying even lower per capita incomes Nonetheless, there is

wide diffusion of a number of basic consumer durables, especially those related to

communication, including motorcycles, mobile phones and TV sets Poverty has

plummeted by two-thirds in the four years to 2007, to 4% of the population, when

measured on a consumption basis using either the official low-income line or the similar

World Bank poverty line (World Bank, 2009) The proportion of the population in poverty

Table 1.1 Level and improvement of living standards

decile urban Rural Urban

Highest decile urban Ownership per 100 households in 2008 Growth 2002-08

Level Real annual growth, local currency

Consumption per household ($, market exchange rate) 2 115 4 709 11 332 7.7 7.0 8.8

Source: China Statistical Yearbook, World Development Indicators.

Box 1.2 Improving energy efficiency and reducing pollution

While delivering substantial improvements in living standards, sustained rapid

economic growth has led to considerable environmental pressures, particularly in the

form of air and water pollution (Vennemo et al., 2009) Estimates indicate that China has

become the largest emitter of greenhouse gases, even though in stock terms, that is not

projected to be the case before mid-century Ambient concentrations of particulate matter,

the most damaging types of air pollution for human health, are high in almost all Chinese

cities Recently, over half of all rivers and freshwater lakes were deemed by the authorities

to be suitable only for irrigation or industrial purposes

Government efforts to reduce pollution have focused on energy conservation and

efficiency (Zhou et al., 2009; Wang and Chen, 2010) Following a sharp rise in the energy

intensity of production after 2002, the government announced a target to reduce energy

intensity by 20% between 2005 and 2010, as part of the 11th Plan In order to achieve this

target, a number of policies and initiatives have been adopted, many directed at industry,

which is a major source of air pollution

One element of the strategy focuses on improved monitoring of industrial energy usage

and the dissemination of information on the use of energy-saving products and

techniques Specific targets have been set for the closure of inefficient and outdated

capacity in energy-intensive industries, including steel and electricity generation, and

funding has been allocated to upgrade and renovate industrial infrastructure such as

coal-fired boilers Revised corporate income tax arrangements introduced in 2008 grant

preferential treatment for investment in energy-saving and environmentally-friendly

projects New labelling and energy-usage standards have also been adopted for consumer

durable goods and tighter emissions standards have been introduced for vehicles

(Zhou et al., 2009).

Note: Estimates of cumulative emissions of carbon dioxide from 1900 to 2060 are based on emission data from

CDIAC available for the United States and China from 1900 to 2005 (prior to 1900, emissions are assumed to be

nil) Projections beyond 2005 are taken from the unchanged policies baseline in OECD (2009) until 2050 and

extrapolated using the final projection value thereafter Energy intensity is measured as energy consumption

divided by real GDP measured in constant US dollars at PPP exchange rates.

Source: CEIC Database, NBS, CDIAC, IEA and OECD.

1993 =

100 C Energy intensity of GDP

would be lower still if measured by income, as even the poorest rural groups save a

considerable portion of their income Indeed, given past differences between the income

and consumption measures of poverty, the number of people below the income poverty

line may have fallen to less than 30 million, down from 99 million in 2001 Furthermore,

numerous disparities remain across the country both between regions and between the

rural and urban areas These differences are assessed in Chapter 5, which looks at the

evolution of inequality over the past decade and at the impact of some of the government

programmes introduced in recent years

The provision of public goods has also increased considerably over the same period

Highway density more than doubled, access to tap water in urban areas became almost

universal (in 2000, one third of urban households still did not have any access) and almost

two-thirds of wastewater is now treated before disposal Access to the gas network has

expanded markedly, so that only one-eighth of the urban population does not have access

to this form of energy This should help reduce the use of coal for domestic heating, a major

source of air pollution and CO2 emissions Against these improvements, while the use of

desulphurisation facilities at coal power plants has risen to 66% of plants in 2008, from just

3% in 2000, rapid growth in coal use has kept sulphur dioxide emissions high and

underpinned sustained growth in greenhouse gas emissions (Box 1.2)

China’s importance in the world economy has grown as well

Sustained rapid economic growth has resulted in a sharp rise in China’s share of world

production Differences in price levels across countries make international comparisons of

the value of output difficult Indeed, because of revisions to purchasing power parities

made in 2007, China’s share in world GDP in 2005 was revised down by 40% to 9.7% due to

an underestimation of the price level in China – as foreshadowed in the first OECD Economic

Box 1.2 Improving energy efficiency and reducing pollution (cont.)

In November 2009, the government announced that it would aim to reduce carbon

dioxide emissions per unit of GDP by 2020 by 40 to 45% compared with 2005 A major effort

will be made to raise the share of renewable and nuclear energy in total energy supply from

8% in 2008 to 20% by 2020 Given such an increase in non-fossil fuels and the reduction in

emissions intensity likely to be achieved between 2005 and 2010, the government should

be able to achieve its emission reduction target with a fall in energy intensity of 2% per year

between 2010 and 2020, half the rate expected between 2005 and 2010 The government

also plans to reduce carbon emissions and to increase carbon sinks by expanding forest

coverage by 40 million hectares by 2020 compared with 2005

A number of reforms could be adopted to help achieve the government’s objectives of

further reducing energy and carbon intensity targets Some reforms to better align

domestic and international energy prices have been implemented, particularly for coal

and oil However, electricity prices continue to be heavily regulated and remain well below

generation costs, thereby providing poor signals to end users More broadly, new

market-based policy instruments such as carbon taxes or cap-and-trade schemes could be

introduced Such instruments offer flexibility in meeting targets, are likely to be far more

cost-effective than administrative restrictions and provide incentives for innovation

(Herd et al., 2004; Cao et al., 2009) Finally, moving away from policies that favour

manufacturing and investment in heavy industry over less energy-intensive services

activities and consumption would yield environmental and other benefits

Survey Nevertheless, the latest estimates indicate that it had risen to 11.3% of world output

by 2008 On the basis of current market prices and exchange rates, the share of China in

world GDP is much lower, at 7.2% in 2008 Most of the difference between these two

measures reflects lower prices in China for non-traded goods, particularly services or

goods with a high services component The Chinese manufacturing sector is highly

integrated into world markets: between 30% and 40% of its value-added is exported and

much of the remainder is highly substitutable with foreign goods Hence, for this sector,

market prices can be used in international comparisons (lower prices for Chinese products

are then taken as signalling lower quality) China is estimated to represent about 15% of

world value-added in manufacturing, similar to Japan and more than 50% greater than its

share in world PPP GDP (Figure 1.2) Given the pace of expansion of the Chinese economy it

may well overtake the United States in the next five to seven years to become the world’s

leading producer of manufactured goods Indeed, for certain industries, China is already

Figure 1.2 Shares in world manufacturing output

Source: World Development Indicators; International Organization of Motor Vehicle Manufacturers; World Steel

0 5 10 15 20 25 30

% A Shares in world manufacturing value-added at constant 2000 market prices

% B Shares in production of passenger cars

0 5 10 15 20 25 30 35 40

%

C Shares in world steel production

0 5 10 15 20 25 30

% A Shares in world manufacturing value-added at constant 2000 market prices

% B Shares in production of passenger cars

0 5 10 15 20 25 30 35 40

%

C Shares in world steel production

the leading producer For steel, it overtook the United States over a decade ago and Europe

seven years ago For passenger cars (excluding light commercial vehicles), China overtook

the United States in 2006 and now represents 20 to 25% of world output

Growth has been led by investment and sectoral reallocation

China’s exceptional growth performance over the five years to 2008 primarily reflects

a continued rapid expansion of the capital stock, which is estimated to have contributed

around 6 percentage points annually to growth over this period (Table 1.2) Labour force

growth has been fairly subdued, partly due to the one-child policy (Chapter 7) This leaves

over 4 percentage points per year that is not explained by factor accumulation Although

the part of growth not explained by factor accumulation has varied significantly between

five-year periods, most of this variation has been due to cyclical fluctuations: a smoothed

series suggests that the unexplained part of growth has been quite stable (Chapter 4) By

the standards of advanced economies, this would suggest an extremely vigorous growth in

efficiency However, in the case of China, it mainly reflects the re-allocation of labour away

from agriculture towards services and manufacturing After controlling for this

re-allocation, the remaining growth of efficiency (or multi-factor productivity, MFP) is in fact

estimated to have slowed down One reason may be that productivity in the state sector

has slowed down To what extent MPF can accelerate going forward will depend inter alia

on innovation and R&D policies (Box 1.3)

Table 1.2 Factors contributing to output growth: 1988-2008

Change from 1998-2003

to 2003-08 Percentage points

Source: OECD estimates.

Box 1.3 Enhancing innovation capacity

The resources devoted to science and technology in China have expanded rapidly in

recent years and it now ranks amongst the top countries in total research and

development (R&D) spending and the number of researchers Nevertheless, R&D intensity

in China still lags behind OECD countries, with gross R&D expenditures amounting to

around 1.5% of GDP in 2007 compared with an OECD average of 2.2% When measured in

terms of spending by industry, R&D intensity in China is even lower relative to OECD

countries, especially in high-tech industries (Table 1.3) This holds also for high-tech

export industries, which lack a large R&D base in China and continue to rely heavily on

foreign-sourced technology embodied in FDI and imported inputs For this segment, the

share of value-added devoted to R&D was only one-tenth of that in the United States

in 2005 Indeed the R&D intensity of Chinese high-tech firms is lower than that of

medium-technology firms in OECD countries

Making more efficient use of physical capital

Gross fixed capital formation has soared over the five years to 2008, rising

cumulatively by close to 90% according to OECD estimates This corresponds to an annual

increase in the capital stock averaging nearly 12% During this period, the rate of return on

capital in the more commercial part of the economy (excluding housing and general

government) is estimated to have been stable at around 12% In industry, rates of return on

physical assets – measured at historic cost and before interest, dividends and corporate

taxation – have risen, in contrast to the economy as a whole Of particular note is the

Box 1.3 Enhancing innovation capacity (cont.)

Improving innovation capacity and performance in China will become increasingly

important for sustaining growth over the longer term as productivity levels approach those

of OECD countries and growth becomes more dependent on improvements in technology

In addition to further expanding resources allocated to R&D a key challenge for innovation

policy will be to improve the productivity of the innovation sector (OECD, 2008) While R&D

output has risen, notably on measures such as scientific publications and patent

applications, the strong growth in R&D-related inputs does not seem to have led to a

commensurate rise in outputs In addition, the nature of R&D in Chinese high-tech

industries is different from their foreign counterparts and at least some measures of

output are likely to overstate the true extent of innovation For example, while patent

registrations in China have soared in recent years, they tend to focus on incremental

changes to production technology rather than fundamental innovation (Puga and

Trefler, 2010)

As argued in a recent OECD Innovation Policy Review of China (OECD, 2008), reforms in this area

should focus on improving the framework for innovation This will require strengthening the

intellectual property rights system so as to provide greater financial incentives for domestic

innovators and bolster the confidence of foreign innovators investing in and exporting to

China Although the patent system in China is now in line with international standards and

conventions, infringement of intellectual property rights remains a problem This suggests

that improving enforcement capacity, which remains relatively weak, should be made a

priority Modern institutions and other mechanisms are needed to ensure that public funding

and other resources are allocated more efficiently and greater efforts are needed to nurture a

high-quality science and technology human capital resource base Moreover, many of the

broader reforms detailed in this Survey will also support a stronger innovation performance In

particular, further liberalisation of the financial sector (Chapter 3) will help improve

innovators’ access to finance, while moves to strengthen market competition (Chapter 4) will

provide a greater impetus for firms to innovate

Table 1.3 R&D Intensity of Chinese companies by level of technology

increase in the rate of return for domestically-owned private companies in the industrial

sector, to over 20%

Amongst state-owned enterprises (SOEs), profitability varies considerably For the

100 largest SOEs, rates of return on assets have been high – averaging nearly 25% in 2007

Such high returns occur because they are predominately engaged in resource-extraction

industries or are in sectors, such as tobacco processing, where entry is prohibited Owing

to the absence of resource taxation or royalties channelling the natural resource rent to the

State, SOEs in these two more narrowly-defined segments achieved a 39% rate of return

in 2007 In other sectors, though, the SOEs achieve poor rates of return They barely break

even in petroleum refining and make low returns in electricity and water due to price

regulation Such controls effectively close these industries to competition The third

category of SOEs, comprising some 15 000 smaller companies in 2007, tends to display low

rates of return compared with the private sector

The high rates of return achieved by privately-owned companies have enabled them to

grow rapidly, bringing a marked increase in economic efficiency By 2007, the assets of

companies owned by the domestic mainland private sector had almost reached the level of

the state-held sector excluding the 100 largest companies (Figure 1.3) Once the assets of

the companies owned by non-mainland companies are added to those of the domestic

private companies, the private sector now has a bigger asset base than the total

state-controlled sector – a striking reversal compared with 2003 Government policy has been to

consolidate SOEs to create world-class companies In industry, the 100 largest SOEs

account for just over one third of the total assets of the state sector Yet, in 2007, they

generated less than 5% of total exports, 85% of which were accounted for by

foreign-controlled and domestic private companies, a share that has been stable since 2004

The shift in employment in industry has been even greater than the shift in assets The

100 largest SOEs provide little employment in comparison to their use of assets, but the

number of workers they employ has been stable In contrast, employment in the remainder

Figure 1.3 Physical assets and employment in industry by ownership

Source: National Bureau of Statistics Industrial Microdatabase.

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Persons (Mn)

B Employment

100 largest state Other state owned companies

of the state-owned sector has declined An important factor enabling private companies to

expand employment rapidly has been their ability to finance their expansion internally.1

Since 2003, continued SOE restructuring has raised their productivity (Chapter 4)

However, the distribution of firm-level productivity differs substantially from countries

without large state-owned sectors For example, the tail of low-MFP firms in China is much

greater than in the United States The dispersion in MFP appears to be related to

ownership, with higher state ownership being associated with a greater variance (Hsieh

and Klenow, 2009) These authors suggest that had the dispersion of productivity in 2002

been as low as in the United States, MFP in manufacturing would have been 30% to 50%

higher As shown in Chapter 4, part of this differential had been eliminated by 2007, with

reallocation generating productivity gains of around 1-2% per year

The distribution of rates of return between the different sectors of the economy raises

questions about competition In a competitive market, rates of return should be similar

across sectors In China, private sector assets and employment have steadily increased but

the pre-tax rates of return of private companies are more than quadruple the cost of

borrowing from banks This suggests that, despite the private sector’s stellar performance,

barriers have prevented it from growing even faster The persistence of these extraordinary

rates of return also points to financial markets inefficiencies (Chapter 3)

The regulation of energy prices and the failure to channel resource rents to the budget

impose significant environmental and fiscal costs on society The excess return on capital

of the extractive industries amounts to almost 0.6% of GDP, about three quarters of the cost

of the healthcare programme announced in April 2009 (Chapter 8) The low rate of return

in petroleum processing and electricity represents a subsidy to both intermediate and final

consumers Further subsidies may occur in the retail distribution sector of the industry

The differences between domestic and world prices also act as a barrier to entry in oil

distribution since independent retailers, using imported products, find it difficult to

compete with outlets owned by vertically integrated SOEs

Mobilising and nurturing human capital

Since 2003, the reallocation of resources away from agriculture has contributed

markedly to sustaining economic growth During this period the absolute number of

people whose principal activity is agriculture started to decline for the first time, though

by 2008 just under 40% of the labour force was still employed in agriculture At the

household level, there is evidence that the marginal product of an additional worker in

agriculture is low This is also reflected in the sector’s average productivity, which is six

times lower than in the rest of the economy This large differential in productivity across

sectors has meant that the decline in the employment share of agriculture has provided a

notable contribution to aggregate productivity growth The contribution from this shift can

be assessed by comparing actual productivity with productivity that would have resulted

had employment shares remained unchanged (Figure 1.4) The extent of this contribution

has varied over the past decade, and indeed was negative during the initial period of SOE

downsizing However, over the past five years, the contribution has been even larger than

that observed earlier in the process of liberalisation

Movement of labour from rural to urban areas also helps improve productivity

However, considerable barriers continue to hinder internal migration This is due to the

system of household registration (hukou): while it allows so-called temporary mobility, it

links most social and educational benefits to the area where the person is registered, rather

than living Medical benefits, in particular, are often linked to the area of registration, while

pensions are rarely portable Hence, people moving from one town to another typically lose

the right to many benefits Rural-to-urban migrants fare even worse, as they generally have

no labour contract, are not affiliated to the social security system and are not paid the

hourly minimum wage Finally, rural residents do not have the same property rights as

urban residents and may lose the right to use their land if they move Population

movement is essential to urbanisation as the existing natural growth of urban areas is very

limited due to the one-child policy The extent to which these barriers hold back migration

is discussed in Chapter 6, which also considers how changes in the labour law will affect

temporary residents and the labour market more generally

In recent years, the education system has expanded rapidly, which will improve

productivity over the longer run Local governments have been pushed to ensure that all

children complete primary school.2 In addition, efforts have been deployed to ensure that

by the age of 15, all children have had nine years of primary and junior high school

education By 2008, school fees had been abolished throughout the country for this level of

schooling and textbooks were provided free of charge in the West The result was that by

that year, 90% of those children who had entered primary school in 1999 graduated with

nine years of schooling (Figure 1.5) In addition, in the early 2000s, universities made

significant investments with a view to more than triple the number of new entrants into

tertiary education Even though a large part of the cost of university education is met

through fees charged to the students, the number of new entrants rose by 60% in the five

years to 2008 By that time, over 23% of the children who had entered school in 1983

graduated from tertiary education Chapter 5 suggests that one of the main reasons for the

growth of inequality as the labour market became more market-oriented was the rise in

the returns to education towards the levels found in advanced economies This underlines

Figure 1.4 Impact of changing sectoral employment shares

on productivity growth

Annual percentage change, using 1990, 2000 and 2005 employment shares

Source: OECD estimates, data from China Statistical Yearbook and CEIC.

1 2 http://dx.doi.org/10.1787/777282828274

-2 0 2 4 6 8 10 12 14

the importance of improving the quantity and quality of education in rural areas as a way

of reducing rural-urban income differentials

Weathering the global crisis

The onset of the crisis

Economic growth over the five years to 2008 was not uniform Very rapid expansion

in 2006-07 led to overheating, with an upsurge in inflation that was exacerbated by

temporary disruptions in certain food supplies (Table 1.4) During this period the structure

of demand became particularly unbalanced World demand was buoyant, leading to a

widening in the current account surplus In addition, the share of output devoted to

investment rose sharply (Table 1.5) All of the increase in investment came from the

enterprise sector In both the household and the government sector, saving grew much

faster than investment – perhaps in response to the rapid growth in incomes As a result,

the principal counterpart to the increase in the current account surplus was the increase

in household and government saving In terms of the level of saving, all three institutional

sectors have saving propensities well above those in the OECD area In particular,

household saving was 12 percentage points of GDP higher in China than in the OECD area

during the period 1992 to 2002 (Table 1.6) but during this period the current account

surplus average only 1.4% of GDP

Figure 1.5 Level of education by year of entry to primary school

Percentage of age group graduating from each level of education in 2008

Source: China Statistical Yearbook and China Data Online.

1 2 http://dx.doi.org/10.1787/777300537511

0 10 20 30 40 50 60 70 80 90 100

0 10

Table 1.4 Macroeconomic developments and prospects

Note: Inflation is measured by consumer price index.

The overheating evident in 2007 led the People’s Bank of China to hike reserve ratios,

and, as inflation rose, interest rates Combined with the ongoing global slowdown, this led

the economy to slow markedly during 2008 By the third quarter of 2008, real GDP growth

had declined to an estimated 6.4% rate (on a seasonally-adjusted annualised

quarter-on-quarter basis) The intensification of the global financial crisis in that quarter-on-quarter was

accompanied by a collapse in world trade and in China’s exports (Figure 1.6) Even though

China is less dependent on exports than may be suggested by the share of exports in GDP

(Box 1.4), the magnitude of their drop made for a large dent in growth, especially if spillover

effects are taken into account (Cui et al., 2009) Imports also declined sharply, partly

because a sizeable portion thereof serves as inputs for exported goods

Crisis response

From mid-2008, the government reacted quickly as the world economic downturn was

adding to policy-induced domestic weakness First, the crawling exchange rate

appreciation against the dollar stopped in July 2008 Second, monetary policy was relaxed

with a series of cuts in interest rates and reserve ratios, which brought down the

central-bank-determined one-year bank lending rate to 5.3% (Chapter 2) Last and not least, a

series of fiscal measures wereannounced (Table 1.7) The largest of these was a two-year

investment plan of CNY 4 trillion (over 6½ per cent of annual GDP in both years), involving

among others a number of major infrastructure projects.3

Table 1.5 Saving, investment and the current account balance

Per cent of GDP (expenditure)

Source: China Statistical Yearbook, CEIC, ChinaDataOnline.

Table 1.6 Sectoral saving balances in China and the OECD area

% of GDP

Source: National Bureau of Statistics, OECD, United States Bureau of Economic Analysis

Figure 1.6 Evolution of exports and imports during the downturn

Billion of USD annualised, three-month moving average, at constant 2000 prices

Source: CEIC.

1 2 http://dx.doi.org/10.1787/777340266414

Box 1.4 How dependent on exports is China?

In 2008, exports represented around one quarter of final demand in China, as

against 28% in Germany, 11% in India and just 8% in the United States This might suggest

that a large decline in exports could impart a major blow to output and value added in the

country Indeed conventional input-output analysis would suggest that domestic

value-added represents around 80% of the value of China’s exports However, such analysis

ignores the very different nature of exports produced by companies registered under the

foreign processing law and other companies Such firms are able to import goods duty free,

provided that they are subsequently exported and do not enter the domestic tariff area

Most of these firms are foreign owned and their gross production has a high import

content.*

A more thorough analysis by Koopman et al (2008), creating a specific input-output

sector for the companies engaged in processing or assembly, suggested that the domestic

value added of technology-related products is indeed low – ranging between 4% for

computers and related equipment to 15% for telecommunications equipment Overall,

in 2002 – the latest available input-output table – processing exports had a domestic

content of just 18% against 88% for other exports Given that domestic private companies

are less likely to be involved in processing trade, the total value-added component of their

exports is high, at 84% against just 3% for foreign-owned firms Overall, based on this

approach, the domestic content of exports can be estimated at around 50%

The relatively low value-added content of exports implies that the Chinese economy is

less dependent on exports than demand-side indicators would suggest Given that exports

of goods were equivalent to 33% of GDP in 2008, and that the share of domestic

value-added in exports of goods was 49% according to the calculations of Koopman et al., the

share of value added generated by exports in GDP was probably only around 16% The

dependence of gross national product on exports is even lower given that the

foreign-owned firms typically have pre-tax profits exceeding half of value added.

* For example, Linden et al (2009) show that while an Apple IPod sold for $300 in the United States in 2005

entered China’s export data with a value of around $150, its local content did not exceed a few dollars.

600 700 800 900 1000 1100

Table 1.7 Spending plans and tax cuts announced between October 2008

and April 2009

CNY, billion over two years Per cent

% of 2008 GDP per year

New ongoing spending programmes

Miscellaneous programmes and tax changes (cost unknown, ongoing)

4) Total of above spending and tax changes (2 + 3) 850 100.0 2.83

Source: Government websites and Reuters.

The total stimulus from the national government exceeds its part (CNY 1.8 trillion) of

the investment plan since a large number of other stimulus measures have been

introduced ranging from consumer subsidies to aligning the VAT regime on exports with

standard international practice Some of the measures concerned the housing market,

where for instance the regulations of the mortgage financing of a household’s second

property have been relaxed In addition, banks were encouraged to set the interest rate on

mortgages at 70% of the one-year bank lending rate All told, the fiscal measures additional

to the fiscal plan will likely exceed CNY 850 billion (2.8% of GDP) in 2009 In December 2009,

the government announced that these measures would be prolonged into 2010, with the

exception of reductions in taxes on housing where it was judged that the market was

sufficiently buoyant without any further stimulus

At the same time, monetary policy was further relaxed Informal lending quotas on

banks were lifted Liquidity was increased by lowering the extent of sterilisation of capital

inflows, so that interbank interest rates fell below the regulated deposit rate This initially

produced a surge of commercial paper issuance by non-banks at close to interbank rates,

which was bought by banks The non-financial companies then deposited the proceeds,

arbitraging the difference between the market and regulated rates of interest With the

normalisation of credit growth from July 2009, these opportunities disappeared and the

short-term loans started to be transformed into longer-term ones

The major part of the CNY 7 trillion credit growth between November 2008 and

June 2009 went to local-authority-owned entities to finance infrastructure (these entities

are also known as urban infrastructure development corporations or UIDCS).4 Such lending

was at the origin of many of the bad loans at the end of the 1990s There are no national

statistics on the size of these institutions but they do not appear to be as well managed as

their counterparts in other countries (World Bank, 2007)

In conjunction with the stimulus package, the government made a series of policy

announcements aimed at strengthening ten priority sectors: shipbuilding, petro-chemicals,

light industry, equipment manufacturing, non-ferrous metals, textiles, electronics and

information technology, autos, iron and steel and logistics These include financial

assistance measures, such as rebates on light commercial vehicle purchases for farmers and

reductions in sales taxes for small passenger vehicles Much of the focus is on restructuring

and improving efficiency (including with respect to energy use) and innovation, with a view

to boost the competitiveness of the larger incumbent SOEs This includes efforts to address

over-production in heavy industries, notably iron and steel, non-ferrous metals and cement

However, central government guidelines to that effect are not always effectively relayed and

implemented at the sub-national level For example, overall investment in the cement

industry soared in the first half of 2009, even though excess capacity is already considerable

and small, inefficient producers fail to be closed down

Impact on the fiscal position

The general government sector entered the slowdown with a surplus of over 5% of

GDP in 2007 (Table 1.8) The main reason for the increase in the surplus over the previous

five years was a very conservative spending policy Most of the fall in public spending came

from lower government consumption and capital transfers relative to GDP Capital

formation and social transfers remained steady As a result, there was some re-orientation

of public spending towards social ends, in line with OECD recommendations (OECD, 2005)

from corporates and the banking system, as the winding down of provisioning lifted banks’

profits substantially Social security contributions also rose, reflecting the widening

coverage of the system

A factor complicating the analysis of the government accounts is the sale of land-use

rights – a major source of local government revenue The associated receipts are supposed to

be shared between the local and the central government but are usually kept off-budget locally

The government’s share amounted to 3.5% of GDP in 2007, according to the national accounts,

with a further 1.5% accruing to households Even after controlling for these sales, the fiscal

balance derived from the government’s monthly data tends to be about 3% of GDP lower than

the general government balance reported in the national accounts with a lag of two years

Between the third quarter of 2008 and the second quarter of 2009, government

expenditure rose by nearly 3½ per cent of GDP (Figure 1.7), somewhat less than the

estimates of the cost of the package shown in Table 1.6 However, since the third quarter

of 2008, tax receipts have started to rise markedly, offsetting about two-thirds of the impact

on the deficit Moreover, since public finances started from a strong surplus on the eve of

the crisis, the fiscal deficit remains small Of the stimulus measures that pass through the

Table 1.8 General government appropriation account

Percentage points of GDP (expenditure)

government budget, only one-third represents permanent increases in outlays, notably for

rural pensions, better health insurance coverage and refunds of VAT on exports This

suggests that government spending may gradually fall by around 4% of GDP when the

stimulus plan ends

The spending on infrastructure in the stimulus package may last well beyond 2011

Outlays under most of the 285 projects announced since December 2008, with a total value

of just over CNY 2 trillion, are to take place through 2015 If disbursements were spread out

evenly over the lifetime of each project, spending would peak in early 2010 (Figure 1.8) or

even later if the first months of a project are mostly devoted to planning and preparation

Figure 1.7 Government spending and deficit on a budgetary basis

Source: Ministry of Finance, Ministry of Human Resources and Social Security, CEIC.

1 2 http://dx.doi.org/10.1787/777355107621

Figure 1.8 Quarterly outlay path for infrastructure spending

Note: This chart is based on the announced data for the start and completion of 285 projects announced between

December 2008 and October 2009 It assumes that outlays are evenly distributed over the life of the project In reality,

initial spending may be relatively low suggesting the peak may come somewhat later than indicated in the chart.

15 17 19 21 23 25 27 29 31 33 35

Rebalancing over the medium term

The fiscal outlook

China’s public finance position is remarkably strong and can readily accommodate a

permanently higher level of government spending Moreover, a marked slowdown in

government spending after the end of the stimulus programmes and a return to fiscal

surpluses might lead to a renewed widening of the current account surplus The balance

sheet of the government will not deteriorate markedly as a result of the fiscal stimulus

In 2008, gross government debt amounted to only 21% of GDP (Figure 1.9) At the same

time, the surpluses of the National Social Security Fund and the numerous local social

security funds, which are largely held as bank deposits, were of the same order of

magnitude Moreover, the government does not carry the value of its stock holdings (worth

50% of annual GDP in mid-2009) on its balance sheet, nor the value of urban land it owns.

In 2009-10, the deficits due to the stimulus plan will increase gross debt by about 3% of GDP.

However, given rapid economic growth, the gross debt ratio will barely budge After

allowing for the projected continued increase in social security assets, government net

debt will not exceed 3% of GDP in 2011 Beyond that horizon, and assuming an economic

cruising speed of around 10% per annum over the medium term, the current level of public

spending could be maintained, with the government still achieving a net creditor position

over time Hence, there is ample fiscal space to continue to step up public spending in the

social sphere even as other types of stimulus spending are phased out

Private consumption

Private consumption has not played a major role in sustaining domestic demand over

the past five years During the decade to 2002, household consumption remained fairly

stable around 45% of GDP, with the saving rate fluctuating around 30% of personal disposable

income (Table 1.9) Between 2002 and 2007, however, the share of household consumption in

GDP fell sharply In part, this reflected a drop in the share of employee compensation in GDP,

Figure 1.9 Financial assets and liabilities of the government

Government includes the national government and local social security systems

Source: China Statistical Yearbook and OECD projections.

1 2 http://dx.doi.org/10.1787/777410164532

-5 0 5 10 15 20 25 30

related notably to the shift of employment from agriculture, where the labour share is very

high, to industry and services, where it is much lower Another important contributor to the

falling share of consumption has been the jump in the household saving ratio, by nearly

10 percentage points of disposable income between 2002 and 2007

This jump in the household saving rate cannot be attributed to the absence of a social

safety net The absence of state pensions and health care in rural areas has been a

longstanding feature of the economy, while in urban areas there has always been a form of

social safety net Overall, government transfers to households averaged just under 4.4% of

household disposable income between 1992 and 2002 However, in the following five years,

the safety net expanded somewhat and social benefits increased by almost 2.5 percentage

points of personal disposable income, at the same time as saving rose However, urban

households may have tried to offset the prospective reductions in state pension benefits that

came into effect during that period (Chapter 7) by saving more (Feng et al., 2009) The rising

cost of education may also have pushed up the saving rate (Chamon and Prasad, 2008), as a

rising proportion of families sent their children to higher education A further explanation

could be that households in the two highest deciles (which account for half of total saving)

experienced an unusually large acceleration in real income relative to the earlier period,

when restructuring was occurring To a large extent, each of these factors is of a transitory

nature, pointing to the likelihood that the household saving rate may decline in the future

While the recent increase in household saving cannot be attributed to the low level of the

social safety net, cross-country analysis of developing countries suggests the high level of

household saving in China prior to 2002 may be related to the low social safety net Indeed,

one study of 11 developing countries found that an increase of government transfers to

households amounting to one percentage point of household disposable income would

lower the saving rate by 0.4 percentage points (Schmidt-Hebbel et al., 1991).

Recent data suggest that this may have begun to happen The growth rate of real retail

sales has picked up from 12% per annum in 2006-07 to 16% by mid-2009.5 Urban households

Table 1.9 Household appropriation account